Fed is expected to maintain high interest rates this week, but a reduction announcement is anticipated in September

The Federal Reserve may lay the groundwork for lower interest rates this week as inflation in the U.S. has begun to decline. Specifically, the American central bank is likely to keep its benchmark interest rate at levels between 5.25% and 5.5% following this week’s meeting, and although the decision on interest rates may seem insignificant, the meeting should also serve to further pivot monetary policy, potentially starting a reduction in interest rates as early as September.

– The Fed is approaching a rate cut, and this should be confirmed after this week’s meeting, said Brian Sack, former head of the New York Fed, to FT.

The rise in consumer prices has significantly slowed in recent months, alleviating fears that flared up earlier this year over a resurgence of inflation. Furthermore, the labor market, which previously contributed to inflationary pressures in the U.S., has also returned ‘under control’, and Fed officials want to maintain a healthy labor market, understanding that keeping interest rates too high for too long jeopardizes this, FT reports.

The Fed stated back in June that there had been only ‘modest progress’ towards the targeted inflation rate of 2% and that they are ‘very closely monitoring risks’. Moreover, they have long stated that they would not reduce rates until they have ‘greater confidence’ that inflation is moving ‘sustainably towards their target’.

Economists expect that the Fed will finally acknowledge that further progress has been made. They also expect that the media statement following this week’s meeting will emphasize that elevated inflation is not the only risk the Fed faces now that the labor market has ‘softened’.

As Fed Chairman Jerome Powell emphasized, the central bank is also at risk of unjustified job losses if it fails to act quickly enough to provide relief to American companies and borrowers.

Ultimately, it is very likely that monetary policymakers will confirm that they are more confident in their management of inflation and show readiness to lower rates. Powell and other officials have not commented on when they will begin to reduce borrowing costs, instead stating that decisions will be made from meeting to meeting and will depend on inflation trends.

Advantages of Waiting

From this week’s Fed meeting until the one in September, monetary policymakers will receive two sets of reports on inflation and employment, and forecasts suggest that incoming information will confirm the need for rate cuts.

Some economists argue that by delaying rate cuts until September, the Fed is unnecessarily increasing the risk of recession. The central bank, however, sees several advantages to waiting. Specifically, the Fed is learning from its past mistakes, and officials now want to be absolutely sure they have control over inflation before making any major policy moves. Additionally, there is a range of internal opinions on the appropriate path forward regarding interest rates. Back in June, there was almost an equal split among policymakers who predicted only one quarter-point cut by the end of the year and those who pushed for two cuts.

– Powell likely believes he cannot achieve consensus by September, said Ellen Meade, who served as a senior advisor to the Fed’s Board of Governors until 2021 and is now at Duke University, to FT.

– There is a risk of not moving quickly enough, but there is also a risk of moving a bit too early and having to change course. Given what they experienced with rising inflation at the beginning of the year, they are likely inclined towards that second risk, she added.

Peter Hooper, Vice President of Research at Deutsche Bank, also considers it prudent for the central bank to wait until September to begin its easing cycle. Should the labor market weaken much faster and to a greater extent than expected, the Fed could revert to a ‘neutral’ policy stance.

Hooper, who has worked at the Fed for nearly 30 years, sees room for additional rate cuts in November and December before the central bank presses pause until September 2025. At that point, his team predicts quarterly cuts that will gradually bring the benchmark rate back to between 3.5% and 4%.